Illinois has opted not to follow the federal government’s “no tax on tips” provision, meaning tipped employees in the state will remain responsible for paying state income taxes on their gratuities.
The decision highlights Illinois’ unique approach to taxation and raises questions about how workers and employers will navigate compliance under the state’s rules.
Manish Bhatt, senior policy analyst at the Tax Foundation, noted that Illinois does not automatically adopt federal definitions of taxable income for state tax purposes.
“Only those states that begin state-level income tax calculations using the federal definition of taxable income have it automatically incorporated into the tax code,” Bhatt told The Center Square.
“I don’t believe Illinois does that. So I think the states are certainly able to not incorporate that individual sort of exemption on tips and overtime wages.”
In contrast, some states, such as Colorado, use federal taxable income as their starting point—meaning a federal tip exemption could apply there.
Others, like California and New York, base state taxes on federal AGI, which may not carry over the exemption, according to the Tax Foundation.
Analysts emphasize that this decoupling allows states to maintain discretion but creates inconsistencies in how tipped employees are treated across the country.
Bhatt cautioned that employees might mistakenly assume the federal exemption applies to their state taxes.
“It’s not that those individuals are trying to avoid taxation. They just don’t know to add that back into their state income tax,” he said.
Misunderstandings could increase errors on returns or push workers toward professional tax preparation.
Even in states that generally follow federal exemptions, selective carve-outs can create challenges.
Bhatt said, “It’s much more sound tax policy to not create carve-outs for certain taxpayers at the expense of others. More general reform certainly needs to happen to bring the tax burden down for everybody.”
The policy choice may also influence employer behavior.
Analysts warn that exemptions for tipped workers could encourage businesses to shift pay structures or reclassify employees to take advantage of lower tax obligations.
“If this is implemented around the country, there will be the incentive for employers to shift the way that their workers earn their money,” Bhatt said.
Some industries may use tip-eligible positions strategically “to attract and retain workers on the promise of a lower tax bill.”
Equity concerns arise when workers earning similar total pay face different tax treatments.
Bhatt illustrated a hypothetical scenario: a bank teller and a waiter each earning $30,000 would see dramatically different state tax burdens under a tip exemption system, despite taking home comparable amounts.
Illinois’ already high property tax burden compounds these challenges.
Bhatt acknowledged the difficulty in persuading workers that decoupling from the federal provision is prudent policy.
“This is an example where good politics doesn’t always make good policy,” he said. “When you create a carve-out for a certain industry or a certain company, you’re shifting the burden onto somebody else.”
He urged lawmakers to focus on broader, equitable tax reforms rather than selective exemptions.
“Lawmakers should prioritize sound and broad tax reform in the state so that everybody benefits,” Bhatt said.
